Metcash accounts fail to comfort

After 12 years at the helm of wholesaler
Metcash
, chief executive
Andrew Reitzer
must be wondering what he has to do to win the trust of the Australian investment community.

Metcash’s IGA Distribution business defied the worst retail conditions in 20 years to deliver sales growth that is likely to exceed that at Woolworths or Coles in the second half of 2011.

IGA sales rose by 8 per cent in the six months ending April, while Coles is expected to achieve 7.6 per cent sales growth in the June half and Woolworths 4.5 per cent, according to Goldman Sachs.

Metcash’s IGA retailers also maintained their 20 per cent share of the Australian grocery market over the year despite the widespread perception that Coles and Woolworths grew sales by taking share from independents.

Reitzer believes IGA’s latest sales and market share data is proof of the resilience of the independent grocery sector and the Metcash business model.

However, many analysts are questioning the quality of Metcash’s latest results. And it’s not the first time.

Metcash has long polarised the investment community, which is divided between those who believe there is a long-term future for independent retailers and the wholesaler who supplies them and those who believe independents are nothing but road kill in the unrelenting march for market share by the major chains.

Reitzer, who took the reins when South African wholesaler Metro Cash & Carry acquired the former Davids Holdings in 1998, has proved the doubters wrong, delivering total shareholder returns of 460 per cent over the past 10 years.

Related Quotes

Company Profile

However, many analysts remain wary about Metcash’s performance, and the latest results are a case in point.

What has intrigued analysts this year is a 52 per cent, or $152 million, drop in cash flows and a 28 per cent, or $200 million, spike in year-end inventories. Days inventories rose from about 26 to 31 days, the highest for years, and the cash realisation rate fell to 48 per cent, half that of 2010.

Metcash explained that it ordered more stock to ensure it could properly supply retailers in the two shortened weeks after Easter.

The higher inventory levels also reflected the rise in promotional intensity, driven by consumer frugality. When products are discounted consumers are now buying six times the amount rather than twice the amount they would normally buy, so retailers need to buy more to have promotional products in stock.

Analysts suspect Metcash may have pre-bought and partially on-sold stock to pull forward income and supplier rebates from May into April, boosting sales and earnings.

Metcash is said to have bought so much extra stock it had to rent additional warehouse space.

Credit Suisse believes the pull forward of 3 per cent of sales may have boosted earnings by $10 million, overcoming an otherwise flat net result.

But Reitzer yesterday rejected this theory, saying under Australian accounting standards companies can book rebates only when they sell the stock.

Citigroup has a different theory. Pointing to a rise in Metcash’s working capital over the past five years, from 2.8 per cent of sales in 2006 to 4.7 per cent in 2011, Citigroup believes Metcash may be hoping to profit from price rises on the inventory it holds or that Metcash believes it can generate better returns by exploiting favourable supplier terms for early payment.

Analysts have also questioned IGA’s sales growth momentum in the second half, querying why earnings growth fell short of sales growth. IGA’s sales leverage fell to 0.4 times in the second half, compared with 1.5 times in the first half, even though deflation was similar in both periods.

Reitzer says Metcash cut costs in the first half in anticipation of deflation, which was expected to ease in the second half. When it didn’t, Metcash was unable to achieve the same cost reductions.

Reitzer managed to overcome some of the doubts when he spoke to investors yesterday and Metcash shares rose 10¢ to $4.00, recovering the ground lost in the past week.